In more detail
The content of the Bill is similar to that presented in Provisional Measure 1,171/23 and Provisional Measure 1,172/23, including some highlights:
- Possibility for the individual to elect as transparent for tax purposes the controlled entity abroad – similar to “check the box” or tax treatment as “disregarded entity” in the United States.
- The possibility for individuals to offset financial losses and gains.
- Absence of tax effect on foreign exchange variation resulting in gain or loss between the moment of taxation of the profit calculated by the controlled entity and its effective distribution, as dividends.
- Delimitation of the trustee’s liability regarding the availability of resources and necessary information to be provided in the Country.
The Bill was sent with constitutional urgency to the Chamber of Deputies, which means that if the Chamber of Deputies and the Federal Senate do not express an opinion on the proposal, each one successively, within forty-five days, all other legislative deliberations of the respective House will be suspended, with the exception of those that have determined constitutional period, until the vote is final.
If the PL is sanctioned by the President, it will take effect from 1 January 2024.
We highlighted below the main points that may impact individuals tax residents in Brazil, if approved.
Financial investments abroad
With regard to financial investments abroad, PL 4.173/23 brings the following rules:
- Progressive tax rates from 0% up to 22.5% on foreign earnings (applicable to all sections of this alert).
- Financial investments abroad are considered any financial transaction outside the country, among others, including interest-bearing bank deposits, cryptoassets, digital wallets and insurance policies whose principal and income are redeemable by the insured or its beneficiaries.
- The text of the Bill also lists the income subject to this rule. The income from financial investments should be taxed when they are earned (effectively perceived) by the individual, by the cash regime.
- Possibility of offsetting income tax paid abroad, provided that the compensation is provided for in a treaty or there is a reciprocity agreement (limited to the amount of tax paid abroad).
- Income tax paid abroad that is subject to refund, reimbursement or compensation abroad may not be deducted from the individual income tax due in Brazil.
- Tax paid abroad not deducted in the same calendar year cannot be deducted from the Brazilian income tax in subsequent or earlier calendar years.
- Exchange variation of foreign currency will not be subject to taxation up to the limit of USD 5,000.00. Exceeding this limit, the full amount will be subject to a tax rate of up to 22.5%.
- Highlight: The possibility for individuals to offset losses incurred on financial investments abroad with:
- Income earned on operations of the same nature in the same calculation period.
- If the amount of losses in the calculation period exceeds the gains, this portion of losses may be offset against profits and dividends from entities controlled abroad, which have been computed in the income tax return in the same calculation period.
- If, at the end of the calculation period, there is an accumulation of non-offset losses, these losses may be offset with earnings from subsequent calculation periods.
- Losses can be offset only once.
Controlled foreign companies
- Creation of anti-deferral rules for Brazilian tax residents, on profits earned by foreign-controlled entities.
- Definition of controlled entity:
- The entities subject to the regime are entities, incorporated or not, including investment funds and foundations, controlled by an individual resident in Brazil, individually or combined with related persons, such as close family members, that holds:
- Rights that ensure preponderance in corporate deliberations or the power to elect/remove directors and officers.
- More than 50% stake in the share capital.
- There are two criteria for a foreign entity to be subject to the automatic taxation of its profits, on 31 December of each year:
- Jurisdictional criteria: entity must be organized in a jurisdiction of favored taxation or in privileged tax regime.
- Passive income criteria: the rule includes companies abroad with own active income of less than 60% of total income, including royalties.
- Clarification that the calculation of the profit of the entity controlled abroad will follow the accounting standards of the Brazilian commercial legislation, for each direct and indirect subsidiary and with indication of the year of origin of the profits.
- The profits of the foreign-controlled entity be determined individually, in the annual balance sheet of the entity, direct or indirectly owned abroad, excluding from the results of the direct or indirect entity the portion related to the interests of this entity in other subsidiaries (including subsidiaries formed as investment funds).
- Allowed the offsetting of losses calculated from 2024 with subsequent profits, and possibility of offsetting income tax paid abroad on the profit and income of the controlled entity.
- Exchange variation of the main value applied in the entity abroad will compose the taxable capital gain at the time of disposal, write-off or liquidation of investments, including through return of capital.
- Highlight – Exemption on the exchange variation verified between the decision and the distribution of dividends: the exchange variation gain or loss resulting from the difference between the value in Reais of the income taxed on 31 December and recorded as acquisition cost of the dividend credit receivable, and the value in Reais of the dividend distributed subsequently, should not be taxed or deducted in individual income tax calculation.
- Highlight – disregarded entities treatment: Possibility to treat the controlled entity as transparent for tax purposes. If this option is exercised by the taxpayer, he or she must declare the assets and rights held by the offshore entity as if it were held directly by the individual, subjecting them to the taxation regime of individuals. This option:
- May be taken individually for each controlled entity (direct or indirect).
- Irreversible and irrevocable throughout the period in which the individual holds that entity controlled abroad.
- When there is more than one partner or shareholder, the option shall be exercised by all those who are individuals tax resident in Brazil.
- With respect to the report of assets in the Individual Brazilian tax return, the individual shall replace the participation in the entities for the assets and rights, by the cost of acquisition for each one.
- The assets and rights transferred in any capacity by the individual, or by a controlled entity owned by the individual under the above tax regime, to another controlled entity, which the option for the tax regime has not been exercised, shall be valued at market value at the time of the transfer and the value of the difference calculated in relation to its acquisition cost shall be considered income of the individual subject to taxation.
- Specific safeguards to not apply the rules of automatic taxation of profits for companies with operational activities abroad, for financial institutions, holding companies with 60% or more of active income and real estate companies.
Finally, as for Trusts, the Bill regulates the institute as follows:
- Revocable Trust – transparent for tax purposes: assets and rights owned by the trust will remain as personal property of the settlor, and will become personal property of the beneficiaries only when there is the distribution of the trust to the beneficiaries. The distribution will have the legal nature of inheritance or donation, depending on the triggering event.
- Distinction between revocable and irrevocable trusts. In the irrevocable trust there may be the transfer of ownership from the settlor to the beneficiary at a time prior to those provided for in the general rule if the settlor irrevocably abdicates his property rights over the trust assets.
- Income and capital gains relating to the assets and rights subject to the trust shall be taxed by the person who is deemed to be the holder on the date of the chargeable event.
- Highlight – Trustee’s liability:
- The trustee shall make available to the settlor or beneficiaries, as applicable, the financial resources and information necessary to enable the payment of the tax and the fulfillment of other tax obligations in Brazil.
- The settlor, if he or she is alive, or the beneficiaries, if they have knowledge of the trust, shall provide, within one hundred and eighty days from the date of publication of the Bill, for the amendment of the deed of trust or the respective letter of wishes, to include irrevocably and irretractably wording about trustee’s compliance with the provisions set forth in the PL.
- For trusts in which the settlor has already died or lost powers in relation to changes to the trust and the beneficiaries also do not have the power to amend the deed or the letter of wishes, the beneficiaries shall send the trustee formal notice regarding the obligation to comply with the provisions of the PL and request the availability of the information and financial resources necessary to comply with the provisions of the Law.
- The same trust rules shall apply for contracts with similar characteristics.
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Trench Rossi Watanabe and Baker McKenzie have executed a strategic cooperation agreement for consulting on foreign law.